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Outsourcing chickens come home to roost

Tue, 20th Nov 2012

If there’s one practice that the same time embodies both the triumph and bankruptcy of management 1.0, it’s outsourcing.

Its triumph, obviously, is that, pushed by consultancy-cum-IT firms that profit directly from it, mandated by governments using it as a form of stealth privatisation, and seized on by firms desperate to cut costs, everyone does it. Industry researcher Gartner estimates that IT outsourcing alone was worth $250bn in 2011. Manufacturing, HR, payroll, customer service, and management itself (hospitals, prisons, schools) would add hundreds of billions more. ‘Outsource everything but your soul!’ once exhorted an excitable Tom Peters – and to their shame, of course, some companies have even tried that.

It's easy see outsourcing’s appeal. It makes perfect sense to managers who have been brought up to believe that companies are machines, people are a cost to be minimised like any other and shareholder value is the only thing they have to look out for – with management 1.0, in fact. Outsourcing is the economist’s obsession with specialisation, economies of scale and unit activity costs translated into management practice. When IT made it possible to break services down into their separate activities and then recombine them later, wow! Outsourcing seemed finally to promise the Holy Grail of optimising the cost of each and every part.

Which is how its purveyors present it. But it’s a fraud. It doesn’t have to be – in itself, outsourcing is neither good nor bad but neutral – but most of what’s done in its name fails on at least one of three different counts: it’s the wrong thing to do (or done for the wrong reason), it’s done wrongly, and the contract is likely to be rigged in favour of the provider.

Take the latter first. Many of the big consultancies have a vested interest in selling outsourcing, since they are providers too. As you would expect, having had a lot of practice they are good enough at it to make it handsomely profitable for themselves.

Often less so, however, for customers. Whatever they say, the chief reasons companies outsource are to cut cost and shed responsibility. These are both self-defeating. Outsourcing is usually only cheaper because outsourcers’ pay and conditions are worse, which does not make for a happy and productive workforce. Offloading responsibility is similarly a false economy because eventually it comes back to bite you in a tender part of your reputational anatomy, as Nike, Apple and countless other companies have found to their cost.

‘Cheaper’ is in any case usually an illusion. Outsourced industrialised processes are only cheaper in terms of unit costs. But total costs are end to end, and by fragmenting the end-to-end flow, industrialisation invariably drives costs up, while worsening service for the customer.

Conventional outsourcing of this type is the exact opposite of systems thinking, and relying on it has precisely the effect that systems thinkers predict, namely to drive up costs elsewhere in the system. (As W. Edwards Deming insisted: ‘If the various components of an organisation are all optimised, the organisation will not be. If the whole is optimised, the components will not be.’)

As the chickens flap home to roost, the reputational and literal costs of outsourcing are spiralling, more than wiping out any unit-cost gains. The opprobrium visited on the big banks, the utilities and, alas, much of the public sector in response to their charmless, dehumanising service, is one such cost. As Apple among many others is discovering, in a connected world it is no longer possible to decouple supply-chain responsibility from the brand by outsourcing. So if Marks & Spencer outsources garment manufacture to Bangladesh, it will have to pay production workers a living wage, whatever it says or doesn’t say in the contract. Starbucks, Google and Amazon can testify that even laundering technical decisions over tax through accountancy no longer washes whiter.

At higher level, the costs are even more pervasive. Irony of ironies, in order to manufacture in the US, as Foxconn is now proposing, the Taiwanese firm is having to invite dozens of American engineers to its Chinese plants to learn how to do it: US firms have outsourced too long for them to be able to bring production lines back home unaided, Foxconn CEO Terry Gou told President Obama on a recent visit.

It goes further. It is not just that outsourcing has hollowed out the US (and UK) economy to the point where it may be impossible to recreate a viable manufacturing sector: the ‘designed in California, made in China’ model followed by the likes of Apple, far from improving matters makes them worse. By sourcing and assembling abroad, the iPhone alone reportedly contributes $2bn to the US trade deficit. Nor does it create the secure, well-paid industrial jobs in the US that sustained a middle-class lifestyle for those without an advanced degree. Instead, those unfortunates have been obliged to seek employment in services, depressing wages in an already low-paid sector and increasing inequality to the point where it is unsustainable. Systematic outsourcing has contributed to similar structural imbalance in the UK.

As with many other areas of management, the moral of the outsourcing story is: be very careful what you wish for. When viewed in system terms, something that seems obvious and advantageous for conventional managers in an individual firm turns into the economic equivalent of ash die-back, disastrous for the economic ecology as a whole. The outsourcing short cut has turned into a very long way round indeed.  


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User comments

Henning Sieverts :: 28th Nov 12
Simon, what you say is very true, as usual. But there is at least one good reason for choosing to "outsource" a specific set of responsibilities to a sound partner company, namely that it has economies of scale that you cannot achieve independently. An obvious example is accounting, when a small company finds it cheaper and more reliable to hire an accountancy firm to prepare its books and records than to put a qualified accountant on its own payroll. Similarly, most small businesses engage external expertise to maintain their websites. On a larger scale, in the US, where most health insurance is non-governmental and local or regional (and often non-profit), when it comes to providing benefits for prescription drugs, most health plans outsource management and provision to one or another of large, nationwide companies which contract with retail pharmacies at advantageous rates (paying a good deal less than retail prices, and giving incentives to use generic drugs, and enjoying true economies of scale)
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